Copyright 2018 Mitul Kotecha

Having spent the tail end of last week in Singapore and Phnom Penh presenting the Global outlook for 2014 to clients as part of our Asian roadshow it struck me that there is a strong consensus view about a number of market movements this year. In particular, most expect the USD to strengthen over 2014. Indeed just as it looked as though the USD was going to surge into the new year, along comes the US jobs report to spoil the party. Clearly, it’s not going to be a one way bet in 2014.

The surprisingly weak US December payrolls data in which only 74k jobs were added compared to consensus expectations of close to 200k helped to support expectations that Fed tapering would take place only gradually, lending a helping hand to risk assets at the turn of this week.

I don’t believe the jobs data materially changes the picture for the Fed. Adverse weather may have played a role in the weakness in jobs while complicating matters was the drop in the unemployment rate to 6.7% largely due to around 350,000 people leaving the labour force. The data resulted in a drop in US bond yields and a weaker USD although equity market reaction was more mixed. Meanwhile gold and other commodity prices rose.

While risk assets may find some support in the wake of the jobs report this week much of the US data slate will if anything highlight that economic growth is strengthening, suggesting a reversal of some of the price action in US Treasuries, USD and gold. Data releases include a likely healthy increase in core US retail sales in December together with gains in manufacturing confidence surveys (Empire and Philly Fed) and industrial output as well as a further increase in consumer confidence (Michigan sentiment survey).

Additionally several Fed speakers are on tap over coming days, which may give more colour on Fed thinking in the wake of the jobs report. However, it is doubtful that they will indicate that the Fed will not taper as expected in January.

Clearly markets were caught overly long USDs last week as reflected in CFTC IMM speculative positioning data as of 7th January which showed that net USD long positions had reached their highest since September 2013. The pull back in the USD is set to be short lived, however, especially if US data over coming days reveals further improvement as expected.

USD/JPY in particular bore the brunt of the pull back in US yields, as long positions were unwound. A Japanese holiday today may limit activity but much will depend on the propensity for US yields to bounce back, with 10 year US Treasury yields currently around 2.85% compared to around 2.97% on Friday.

Asian currencies have been the most sensitive to US Treasury yields gyrations over the past three months. In order of sensitivity to US 10 year Treasury yields the highest is the JPY, followed by MYR, THB, PHP and SGD. These currencies would be expected to benefit the most in the wake of the drop in yields at the end of last week although as noted any pull back in US yields is likely to prove temporary. While the THB may suffer from political concerns in the near term the other currencies are likely to see some short term gains.

2013 ended with a solid performance by US equities and further pressure on US Treasuries helped by a bigger than expected increase in US December consumer confidence. The S&P 500 ended close to 30% higher over the year while 10 year Treasury yields rose above 3%, registering an overall rise of around 108 basis points over 2013. In contrast commodity prices dropped sharply, with the CRB index recording a sharp drop and ending 5% lower over the year. Meanwhile the USD index ended the year close to where it began although this performance belies some significant volatility over the year, with losses against the EUR and gains against the JPY.

The first trading day of 2014 begins on a more cautious note as a disappointing reading for the December Chinese purchasing managers’ index (51.0 versus 51.2 consensus forecast) will cast a shadow over markets today. Indeed, the data alongside weaker commodity prices will weigh on AUD. Japanese markets will be closed over the rest of the week, while many market participants will not return until next week, suggesting limited activity. Nonetheless, as far as the JPY is concerned the currency is set to remain on the back foot versus USD given the ongoing widening in real yield differentials between the US and Japan.

Meanwhile EUR/USD looks like it will struggle to make much headway over the short term, with only the final reading of the December Eurozone PMI due for release today. The data will likely confirm a relatively healthy looking reading of 52.7, its highest reading since May 2011 but will unlikely provoke much of a market reaction. Instead markets will look ahead to the European Central Bank meeting next week. Recent ECB comments suggest little chance of another rate cut anytime soon despite a very subdued inflationary backdrop. Against this background any EUR slippage in the short term is likely to be limited although further out the relatively inferior Eurozone growth outlook compared to the US, highlights plenty of scope for downside EUR pressure.

Asian currencies will also look somewhat subdued in the wake of China’s softer PMI reading. Additionally a bigger than expected decline in Singapore Q4 GDP release (-2.7% QoQ annualised) will also not bode well although the drop in GDP will be seen as temporary, with official estimates still pointing to growth around 2-4% for 2014. In contrast robust export data from South Korea will be positive for the KRW in line with our view that the currency will be one of 2014’s outperformers along with the TWD and CNH. Elsewhere the THB continues to be hamstrung by political concerns, which are showing little sign of easing ahead of planned elections February 2.

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A solid revision higher to US Q3 GDP at the end of last week sets up a positive tone for risk assets into year end even as they digest the imminent onset of Fed tapering. The data revealed a revision higher to a 4.1% QoQ annualised pace of growth and if anything lent credence to the Fed’s decision to begin tapering. The GDP data will be followed by a series of positive data releases in the US this week including November personal income and spending and a likely upward revision to December Michigan consumer confidence both on tap today.

Tomorrow, November durable goods orders and next week December Conference Board consumer confidence will also paint a picture of broadening improvement in economic conditions, providing further validation to Fed tapering. Against this background US yields should be well supported along with the USD. Into next year US economic outperformance will continue, leading to both higher US yields and a firmer USD.

A Japanese holiday (Emperor’s birthday) today will dampen market action although Japanese data releases over the rest of the week will highlight further progress on the economic front, with November inflation pushing higher and industrial output expanding at a healthy clip. USD/JPY retained a foot hold above 104 but the large extent of short JPY positioning highlights scope for profit taking. Even so, the rise in US Treasury yields suggest limited downside risks for USD/JPY.

There is on little on tap on the data front in the Eurozone allowing markets to digest the steps towards banking union announced last week. Consequently EUR/USD is set to remain rangebound around 1.3650-1.3750.

There may be more interest in events in China as money market conditions and confidence surveys garner interest. Tight money market conditions will weigh on regional sentiment. A likely decline in both the manufacturing and service sector purchasing managers’ indices will also act to dampen Asian currencies reinforcing the pressure already in place from a broadly stronger USD. News in Thailand that the opposition Democratic Party has decided to boycott the Feb 2 elections will add to political uncertainty and pile more pressure on the THB although the regional underperform remain the IDR.

Overall, a thinning in market conditions as both liquidity and market participants disappear for the holidays imply limited activity over coming days. The fact is that the end of the year will market a solid year for equities and a poorer year for bonds but at least the debate over Fed tapering timing has finally been put to the rest. More of the same is likely next year but notably the growth gap between developed and developing economies will narrow, which at a time of heightened competition for capital amid Fed tapering, suggests that capital flows will increasingly be steered towards developed economies.

Dear readers, this is my last post for 2013. Thank you for taking the time to read my blog posts. I wish all Econometer readers happy holidays, success, prosperity and good health in the year ahead.

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The guessing game is finally over as the US Federal Reserve took a major step away from the extremely easy policy conditions implemented since the financial crisis by tapering its asset purchases by USD 10 billion, split equally by reduced Treasury and mortgage backed securities purchases. Indeed the Fed finally put markets out of their misery but successfully massaged the market reaction.

The Fed is set to gradually reduce asset purchases over coming months, likely ending its QE program by late 2014. The decision was supported by most Fed officials but to soften the blow the Fed strengthened its forward guidance, helping equity markets to rally while encouraging the short end of the curve.

Conversely Treasuries came under pressure and yields rose, giving a boost to the USD. Markets are likely to digest the news well in the Asian session following the lead from US markets. Nonetheless, while the Fed decision was predicated on stronger growth, the decision will presage a competition for capital especially among emerging markets.

The biggest FX reaction unsurprisingly (given its greater sensitivity to US yields) came from USD/JPY, with the currency breezing past the 104 level. However, given that US yields have not pushed significantly higher in the wake of the Fed tapering decision the boost to the USD will be limited in the short term. Indeed, FX markets will likely digest the Fed news will little reaction both in major and emerging market currencies in the short term.

Further out, the prospects for contrasting policy stances between the Fed, ECB and BoJ imply that the USD will forge higher against the EUR and JPY as well as other major currencies. Meanwhile, highly correlated currencies with US Treasury yields, in particular in the emerging markets spectrum, including INR, TRY, and BRL, will be the most sensitive to an expected rise in US yields over the coming months.

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Although markets already appear to be in wind down mode ahead of the year end holidays there is plenty of data and events over coming days that could change the complexity of market activity. To begin the week news that that China’s official November purchasing managers’ index remained at an 18 month high will bode well for markets, especially in Asia.

Elsewhere it is still too early to gauge how well the four day spending over the US Thanksgiving holiday fared for US retailers although initial indications suggest that spending will be down on last year. Over coming days there will be plenty of evidence to finalise opinions about what the Federal Reserve will do at its December 17-18 FOMC meeting. US data releases this week include the November ISM manufacturing survey, home sales, Fed’s Beige, US Q3 GDP revision and the November jobs report.

Ahead of the Fed meeting other central banks will be in focus this week including the European Central Bank, the Bank of England and the Reserve Bank of Australia. No change in policy is expected from any of them leaving all the attention on the US jobs report. This ought to ensure that the asset allocation shift from bonds to equities will leave equities around record highs while core bond yields continue to edge higher.

The USD has failed to benefit versus EUR despite higher US yields but has made gains against the JPY and many commodity and EM currencies. I look for the USD to move higher over coming weeks. Overall risk appetite is likely to remain supported into year end although much will depend on the plethora of data releases and central bank meetings this week.

EUR is looking increasing stretched around current levels, especially given the likelihood that the ECB will sound relatively dovish this week, with staff growth forecasts likely to be revised lower and inflation forecasts remaining below target. The strength of the EUR is clearly acting as a counterweight to efforts to ease policy but efforts to sell the currency continue to face renewed buying interest. Technical resistance around EUR/USD 1.3627 ought to provide a short term cap.

GBP has made somewhat better progress against the EUR and there appears to be little to stop its upward progress at present. Meanwhile USD/JPY remains under upward pressure, with last week’s inflation data highlighting that there has been some progress on ending deflation although the likelihood of more Bank of Japan easing in the months ahead suggests that further JPY downside is in store.

Aside from the JPY last month’s biggest underperformers in Asia were the IDR and THB. There is little sign of this pattern changing. Indeed, in terms of Asian FX relative value in terms of North versus South East Asia continues to pay dividends. Both Indonesia and Thailand registered outflows of equity capital last month compounding the pressure on the currencies.

THB has taken another leg lower in the wake of escalating protests over the weekend and looks set to test its 6 September USD/THB high at 32.480. As noted by the BoT governor the protests are affecting the economic outlook. In Indonesia questions about the external balance remain a weight on the currency An expected widening in the October deficit and higher November inflation will not help the IDR today.

Central banks are very much in the spotlight. Whether it’s poor communication or disappointment over the lack of fresh stimulus measures in Japan or opposition to the European Central Banks’ (ECB) OMT policy being debated in the German constitutional court there is much to focus on. Against the background of heightened volatility and elevated risk aversion the Fed FOMC meeting on Wednesday will garner even more attention than usual.

Although no change in policy settings is expected the ability of Fed Chairman Bernanke to communicate effectively the Fed’s strategy over ‘tapering’ will be crucial to determine whether market volatility persists or lessens. Ultimately markets are likely to successfully transition to a world of reduced Fed asset purchases but this may take a while. In the meantime market stress is set to remain elevated.

Aside from the Fed FOMC meeting US data releases are likely to continue to show encouraging signs of housing market recovery, with US May housing starts and April existing home set to reveal gains. Meanwhile, CPI inflation will remain benign in May while the June Empire manufacturing survey today will reveal a slight improvement.

In Europe, there will be attention on a Eurogroup meeting on Wednesday where banking union will be discussed while data releases include the June German ZEW investor confidence survey (slight drop likely) and the flash estimates of June purchasing managers’ indices. These are likely to look less negative although they are set to remain in contraction territory. In Japan, May trade data will likely show a widening in deficit as weaker external demand outweighs the impact of a weaker JPY.

In FX markets USD selling against major currencies is likely to slow. The 4.4% drop in the USD index from its highs in late May has been rapid but it has led to a major shift in positioning. Speculative USD long positions have been cut back significantly, while EUR positioning is almost back to flat after being extremely short in previous weeks. Similarly JPY short positions are beginning to be pared back. I suspect that the EUR in particular will struggle to make much more headway.

Weakness of the USD against major currencies has contrasted sharply with USD strength against emerging market currencies. The sell off in Asian currencies has been particularly sharp although there was some tentative recovery towards the end of last week. The INR followed by the most risk sensitive currencies including PHP and THB have suffered the most over recent weeks.

The INR’s vulnerability has been particular high due to its external funding requirements although it may show some tentative signs of recovery over coming days as its sell off has looked overdone. The Reserve Bank of India policy meeting today offered no help for the INR. Although it was a close call there was a significant minority looking for a rate cut to boost growth. The lack of action will weigh on the INR in the short term.

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The USD has lost steam as US yields appear to have temporarily topped out. The fact that aggregate (minus MXN) USD speculative positioning is marginally below its all time high also points to the risk of position squaring / profit taking on USD longs. However, any downside risks to the USD will be limited.

Consumer confidence data today will highlight the ongoing improvement in sentiment driven by both equity and housing wealth gains. In the debate about early Fed tapering the confidence data will err on the side reducing Fed asset purchases sooner rather than later. Consequently, it seems unlikely that the yields and the USD will drop much further.

Hopes of a calm start to the week were dashed as Japanese equity markets extended their slide and the JPY strengthened. Heightened volatility is frustrating policymaker’s efforts to contain the rise in Japanese bond yields. Although Bank of Japan governor Kuroda noted that Japan could cope with rising interest rates, higher yields could dampen growth at a time when the economy is finally showing signs of life.

Higher JGB yields have led to a narrowing in the US Treasury yield advantage over JGBs, which in turn has helped to push the JPY higher versus USD. Unless the BoJ succeeds in curtailing the rise in yield, USD/JPY is at risk of breaking back below 100.

Like the JPY, the CHF has strengthened in part due to increasing risk aversion. For a change the CHF may garner some direction from domestic news this week, with Q1 GDP, April trade data and the May KoF Swiss Leading Indicator scheduled for release later in the week. The data will likely show that Switzerland is escaping the downdraft from weak Eurozone activity, helped to some extent by the CHF cap.

Encouraging economic news will not imply any change in the CHF cap, however especially given the benign inflation outlook. Higher risk aversion will keep the CHF supported in the near term but any move in EUR/CHF back to 1.24 should be bought into.

The rebound in the JPY and strong CNY fixings have given Asian currencies some support although sideways trading is expected in the near term. Equity capital outflows over recent days in the wake of higher risk aversion suggest some caution, however. South Korea in particular has been a major casualty of equity portfolio outflows this year although a factor that prevented the KRW from strengthening. Our models show PHP and THB as likely outperformers over coming weeks.

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The information published within this blog has been prepared on the basis of publicly available information and other sources believed to be reliable. Whilst all reasonable care is taken to ensure that the facts stated are accurate, the author is not in any way responsible for the accuracy of its contents. The comments are intended to provide clients with information and should not be construed as an offer or solicitation to buy or sell securities, currencies or any other financial product. The author makes no recommendations as to the merits of any financial product referred to in this blog and the information contained does not take into account your personal objectives, financial situation and needs. Therefore you should consider whether these products are appropriate in view of your objectives, financial situation and needs as well as considering the risks associated in dealing with those products. The views expressed here are purely personal and do not represent the views or opinions of TD Securities